A Search for a Chief Who Can Unite Merrill Lynch

LANDON THOMAS Jr.

Tuesday

Oct 30, 2007 at 6:24 AM

Whoever is chosen will have to run both a thriving wealth management operation and a beaten-down bond business.

Call it a tale of two investment banks. Whoever takes over as chief executive of Merrill Lynch will assume control of what is essentially two companies: a thriving wealth management operation growing at 70 percent a year and a beaten-down bond business that could end the year with over $10 billion in credit losses.

The chief executive, E. Stanley O’Neal, is paying the price for pushing the firm into plummeting subprime debt securities. Directors have decided that Mr. O’Neal should leave in the wake of an $8.4 billion write-down and an unauthorized merger approach to a rival bank, Wachovia. But the board has made no formal announcement.

Lost in the criticism of Mr. O’Neal has been any credit he deserved for laying a foundation for the success of Merrill’s asset management business, which combines the $1.8 trillion assets under management by the firm’s brokers and its 49 percent stake in BlackRock, the fast-growing asset management business run by Laurence D. Fink, the prime candidate to succeed him.

Now, the search is on for someone to bring a sense of unity to these businesses and Merrill Lynch as a whole. One possible course being floated yesterday was that the firm would announce an interim solution in the coming days, with a director assuming a temporary supervisory role while the board searched for a successor to Mr. O’Neal. A Merrill Lynch spokesman declined to comment yesterday.

The new chief will inherit a firm riven by discord. The fixed-income traders are demoralized and facing the prospect that their leaders could be forced out in the wake of Mr. O’Neal’s departure, and the asset management side is angry about the damage caused to the Merrill Lynch brand by the losses and his ignominious departure.

As for the board, it has been quicker in concluding that Mr. O’Neal should go than it has been in presenting a framework for his succession.

According to a person briefed on the board’s deliberations last week, there was a sense among directors as late as Wednesday that Mr. O’Neal might be able to ride out the storm. That view changed on Thursday and Friday when his approach to Wachovia was made public and the firm’s employees expressed outrage.

“It’s easy to fire a C.E.O.,” said Jeffrey A. Sonnenfeld, an associate dean at the Yale School of Management. “But when you clear the deck in the guise of good governance, you create a lot of confusion and the internal hiring process can become more like a municipal city council meeting.”

As the board deliberates — and it has been close to three days since it reached a broad conclusion that Mr. O’Neal should go — constituencies inside the firm and out are pushing their favorites.

Many brokers would like to see Robert J. McCann, an amiable executive who heads the brokerage division, take on a broader responsibility. And while Gregory J. Fleming, a co-president, has been hurt somewhat by his role in the Wachovia merger approach, his stature as one of the firm’s top investment bankers and his close relationship with Mr. Fink, the leading contender for the job, make him likely to stay.

A consensus seems to be building that having these two executives in a power-sharing arrangement, with perhaps a more seasoned executive from the outside overseeing them, is the best way to bridge the gulf that exists between the crucial areas of the bank.

Most crucially, the Merrill board must appoint a chief executive with ability to lead and inspire a large organization. Since the late 1990s, when the race to succeed David H. Komansky as chief executive began to heat up, executive office intrigue has been a consistent theme at Merrill. Mr. O’Neal’s candidacy was championed by a cabal of powerful Merrill Lynch insiders with ties to the board, which caused him to beat out Jeffrey M. Peek, then seen as the leading contender. As chief executive, Mr. O’Neal fostered a continuing sense of fear and uncertainty, countenancing feuds and jealousies among his top managers.

On the fixed-income side, the greatest challenge is persuading a skeptical marketplace that the worst is behind Merrill.

While the firm’s stock is by some measures cheap, trading at a price- earnings ratio of just 8 times 2008 earnings, there is still doubt among analysts about the quality of the earnings. Numerous analysts have forecast more write-downs from the firm’s troubled portfolio of collateralized debt securities to come in the next quarter.

The board must also consider whether top executives closely identified with the breakdown in risk management, like the chief financial officer, Jeffrey N. Edwards, and the co-president, Ahmass L. Fakahany, can stay after Mr. O’Neal leaves. Mr. Fakahany is closely linked to Mr. O’Neal, which would diminish his chances of staying, say people inside the firm with knowledge of the discussions. Mr. Edwards’s departure has been rumored for months.

To a large extent the institutional trading business, where the exposure to the troubled subprime securities lies, has been the volatile engine behind the firm’s earnings in recent quarters, pushing them up and then sending them down.

But the firm’s 16,000 brokers remain the envy of the industry with their great brand and their hold on close to $2 trillion in assets. Last quarter, lost in the uproar over the $8.4 billion write-off, the firm’s global wealth management unit, which includes its brokerage unit as well as the stake in BlackRock, posted pretax profit that soared 70 percent over the previous year, with margins growing to an impressive 26 percent.

“You have a great group of financial advisers and an astonishing amount of dollar assets, and it has taken forever to build,” said Barry S. Friedberg, a former chairman in Merrill Lynch’s investment banking division

During the period, Merrill said, turnover of its highest rated financial advisers remained at an historical low, a positive sign that the division is humming on all cylinders.

The rich margins and global sweep of this business is the crown jewel of Merrill Lynch and the main reason why the chief executive of Wachovia, G. Kennedy Thompson, took Mr. O’Neal’s call about a possible merger.

“I would argue that you are valuing the company solely on the basis of the wealth management business and that you are getting the investment bank for free,” said Meredith Whitney, an analyst at CIBC World Markets.

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